Legal reform a path to higher insolvency costs

INSOLVENCY PRACTITIONERS are known for their quick thinking and fast deal-making. However, radical reforms loom that will make chasing creditor funds through the courts a riskier and potentially more costly process.

If these plans are introduced, insolvency practitioners (IPs) will have to carefully consider whether pursuing funds through the courts, with all the associated legal costs, is worthwhile for creditors. However, the MoJ is under pressure to exclude insolvency litigation from this process.

As part of no-win, no-fee deals, solicitors add on success fees. If such a case wins then insurance companies will also take an after-the-event fee.

Should the new proposals be implemented, IPs will receive damages and legal costs if they are successful, though they will be forced to pay success fees and insurance expenses out of the damages, meaning a smaller return to creditors.

In the event of a loss currently, IPs have no insurance or legal costs; it is uncertain if this will continue after the reforms.

Insolvency practitioners' overarching legal duty is to maximise returns, through the courts if necessary, on behalf of creditors against directors or third parties that have harmed a business and committed fraud.

According to insolvency trade body R3's president Frances Coulson, the reforms will "hamper insolvency litigation" and seriously reduce returns to creditors in cases in which directors have "run off with the company's cash".

HMRC alone, as a recurring creditor in the majority of insolvencies, could stand to lose thousands annually from the change.

Small to suffer

The change is likely to affect smaller insolvency cases, the most of which make up the majority of administrations in the UK. IPs in smaller administrations could be forced to seek funding from alternative routes.

The IP might be forced to go cap in hand to creditors of the administration or seek third-party funding said Tim Carter, insolvency partner at Stevens & Bolton.

Arguably, it is unlikely in smaller administrations that IPs will be able to convince creditors to take on the cost risks associated with a court action.

However, third-party funders already take fund cases; currently they take a percentage of any wins. The likelihood is that these third parties will start to increase their percentages if IPs have nowhere else to turn.

Courts are overburdened and under-resourced, which is why the Jackson report was published. It hopes that many litigation cases can be handled through a mediator with the two warring sides meeting to discuss an out-of-court option or settlement.

However, this is not viable in most insolvency cases. In an administration, the IP is usually trying to recoup funds from a fraudulent director in court.

"Often in insolvency cases where there are misfeasance claims, it is difficult to moderate," said Carter.

However, all is not lost. A Ministry of Justice spokesman said earlier this week that the department is considering the impact of the reforms on insolvency litigation.

"Proceedings can bring substantial returns to creditors, including Her Majesty's Revenue & Customs. We are therefore discussing the specific implications with a view to reaching a satisfactory conclusion."